WHAT ARE PENNY STOCKS AND HOW DO PENNY STOCKS WORK?

Penny stocks may sound enticing but do you know what penny stock are and how they work? Find out if these riskier investments are right for your portfolio.

So you've recently overheard someone talking about penny stocks and the massive gains they made on their investment and now you want a piece of the action. While these stocks may sound appealing, they are certainly not for everyone. Before jumping into buying for your first penny stock, it is important to understand what penny stocks are and exactly how do penny stocks work.

 

What is a penny stock?

A penny stock is a riskier, more speculative type of investment where shares of these companies are trading at less than $5 per share. These stocks often trade on pink sheets or over-the-counter bulletin board (OTCBB) and are regulated by the Securities and Exchange Commission with specific rules to follow.

Penny stocks not only have multiple terms, they also have multiple accepted definitions. Although sometimes referred to as penny shares or micro-cap stocks, the latter is often associated with a company's smaller market capitalization (between $50 and $300 million) while penny stocks are categorized by their per share price. While a common acceptance of a penny stock are those trading at less than $1 per share, the Securities Exchange Commission defines penny stocks as those trading under $5 per share. Penny stocks are mostly found outside of the major market exchanges, however, companies on major exchanges with lower stock prices are also sometimes referred to as penny stocks.

 

How penny stocks work?

Penny stocks essentially trade like any other stock while carrying added risk. With lower volume, penny stocks trade hands less frequently making these investments less liquid. Penny stocks are also susceptible to higher price swings, all of these factors make penny stocks dangerous investments.

Due to their lower per share price and smaller market capitalization, penny stocks carry increased risk and are made up of highly speculative, unproven companies. With less coverage from large institutional investors, these stocks offer less information making it tougher to make sound trading decisions. Because they are not required to file with the SEC, the information that is available is often less credible. Penny stocks are also regarded as illiquid investments with less shares of these companies trading hands every day. Less liquidity increases the chances of not finding a buyer and being forced to sell at unwanted prices. Additionally, these companies are often the subjects of price manipulators who will purchase large quantities of a stock, then artificially inflate the share price through false and misleading positive statements (known as pump and dump).

 

Are Penny Stocks Worth it?

Penny stocks can be worth it if the investor fully understands the risk that these securities carry. The investor should only use money that they are prepared to lose and make sure that this investment fits into the strategy of a diversified portfolio. Penny stocks must be navigated with extra due diligence and caution.

Investors should set realistic expectations when purchasing penny stocks recognizing that the odds are usually against them. The buyer must also be prepared for the potential large losses that can occur from these investments. Before buying these types of stocks, ensure that you have amassed a core group of solid companies in your portfolio and make sure that these speculative stocks are only a small fraction of your investments. Before purchasing penny stocks, get used to how they trade with Wall Street Survivor's stock market game and ensure that penny stocks are the right investment for you.

 

8 Things you should know about penny stocks

  1. They are risky

    They carry more risk than regular stocks because of their lower prices per share and higher volatility. Because these are highly speculative investments, they are certainly not for everyone.

  2. They offer less liquidity

    There is a much lower volume of shares trading hands everyday. When fewer shares are being sold, any significant purchase or sale may push the stock to higher or lower levels. Less volume also means the investor runs the risk of not being able to sell their shares at their desired price.

  3. They have small market capitalization

    Hence the term micro-cap stocks, their market capitalization is usually in the range of $50-$300 million. This is the result of a low price per share paired with a low number of shares outstanding.

  4. There is less information available

    This makes it tougher to make sound investment decisions. There are less ratios, reports and fundamentals available and much of the information that is available is rarely from credible sources.

  5. They are volatile

    Extreme price swings can happen weekly or even daily as these stocks are very news sensitive. Traders rarely buy these stocks for their strong fundamentals but rather for the potential of an important new product release, for example the next big pharmaceutical drug.

    When critical news is released, share prices will experience excessive swings in relation to the confidence of the news.

  6. They can be manipulated

    Poor liquidity and lack of information make them susceptible to price manipulators who will first purchase a large quantity of the stock, then artificially inflate the share price through false and misleading positive statements. Scammers will use various media platforms such as newsletters, television or online articles to promote “the next big stock”.

  7. They lack history

    If they are newly formed companies, there is no price history and if they are approaching bankruptcy they will generally have a poor track record. Yes, past performance is no indication of future performance, but it is certainly helpful.

  8. The SEC watches them closely

    Sometimes the SEC will even impose trade halts on these stocks if the price spikes too dramatically and suspiciously for further investigation. The stock may continue to rise or fall while halted leaving the investors with no control and open to potential significant losses.



*** SPECIAL ALERT -- June 27, 2020 -- THREE of this Year's Motley Fool Stock Picks Have Already Doubled! ****

We have been tracking ALL of the Motley Fool stock picks since January 2016. That's 4+ years, 54 months and 108 stock picks. As of Friday, June 26th 3 of their 12 2020 stocks picks have already doubled (TSLA, ZM, SHOP). In addition, 4 of their 2019, 8 of their 2018, 7 of their 2016 and 10 of their 2016 picks have also doubled. Best of all, over these 54 months, the average stock pick is up 111%. That beats the SP500 by an average of 87%. And that's even accounting for all of this COVID mess that has wreaked havoc on some stocks but presented opportunity for other stocks. THAT is how the Fool does so well!
  • Shopify (SHOP) – April 2, 2020 pick and it is already up 163%
  • Zoom Video (ZM) – March 19, 2020 pick and it is already up 107%
  • DexCom (DXCM) picked Feb 20, 2020 right before the market crashed and it is still up 26%
  • Tesla (TSLA) picked January 2, 2020 before the crash and it is up 123% compared to the SP500 -7% so it is ahead of the market by 130%
  • HubSpot (HUBS) picked December 5, 2019 and it is up 46%
  • Netflix (NFLX) picked November 21, 2019 and it is up 42%
  • Trade Desk (TTD) picked November 11, 2019 and up 111%
  • Zoom Video originally picked Oct 3 and it is up 234%
  • SolarEdge (SEDG) picked September 19, 2019 and it is up 44%
Now, no one can guarantee that their next picks will be as strong, but our 4.5 years of expereience has been super-profitable. They also claim that since inception, their average pick is up 424% and now we believe them. You sure don't want to risk missing out. Many analysts are saying that we have passed the bottom of this COVID crisis and stocks will recover quickly. So make sure you have the best stocks in your portfolio.

Normally the Fool service is priced at $199 per year but they are currently offering it for just $99/year if you click this link

CLICK HERE to get The Motley Fool's Stock Picks for just $99 per Year! 




GET UP TO $1,000 IN FREE STOCK

WHEN YOU OPEN A ROBINHOOD BROKERAGE ACCOUNT

Robinhood was the first brokerage site to NOT charge commissions when they opened in 2013. They just past 10,000,000 accounts and to celebrate they are offering up to $1,000 in free stock when you open a new account.

Here's the details: You must click on a special promo link to open your new Robinhood account. Then when you fund your account with at least $10, you will receive one stock valued between $5 and $500. Then, you will get a link to share with your friends. Every time one of your friends opens an account, you will receive another free stock valued between $5 and $500. Click here to learn more about this Special Robinhood offer.

Claim your free stock NOW

(before it's too late)